The Hindu Business Line : Life insurers picking up bonds through swaps

BONDS remained steady last week despite the surge in liquidity driven by large foreign currency inflows. Traders said that even the presence of the oil companies failed to impact the bond or the foreign exchange markets.

Even high oil prices failed to deter the markets, traders said. Oil prices on Thursday rose to a record $62 a barrel and were forecast to rise further.

Given this price situation, bankers said several oil refiners were sourcing foreign currencies.

Despite the demand from oil companies and corporates to take advantage of the Reserve Bank of India's recent notification relaxing the prepayment norms, there was little impact in the markets.

Both these events were likely to affect the balance of payments situation in the form of higher foreign currency outflows, bankers said.

However, forex inflows continued to surge leading to RBI intervention for mopping up the dollars and to infuse liquidity.

Excess liquidity: The excess liquidity on this count was evident from the high mop-up during the reverse repo auctions.

At the three-day reverse repo auction, the RBI mopped up close to Rs 48,000 crore which is the highest in almost 18 months. Intra-week, the mop up was Rs 51,000 crore.

The high liquidity also reflected in the 91-day and the 364-day Treasury bill auctions. At the 91-day T-bill auction, yields dropped sharply to 5.32 per cent against previous week's 5.44 per cent.

At the 364-day T-bill auction, the yield was 5.65 per cent, 24 basis points down from the previous auction figure of 5.89 per cent.

But the changes were mostly only at the short end. The 10-year yield to maturity (YTM) moved on a weighted average basis to 7.05 per cent from 7.03 per cent.

However, the benchmark 7.38 per cent 2015 used for measuring the 10-year yield firmed to 6.95 per cent.

The high spread between the weighted average and the benchmark stemmed partly from the large sales volumes in high-coupon securities.

This included the 10.47 per cent 2015 security that was picked up by Life Insurance Corporation at a YTM of about 7.16 per cent. Insurers were selling short-dated securities at low yields (high prices) and simultaneously picking papers at high yields (low prices).

Firm outlook: The overall outlook remained steady despite shrinking volumes and wide inter-tenor spreads. Volumes were barely Rs 2,500 crore. But, trades were also being done through collateralised borrowings or inter-bank repo operations. The volumes in repo operations, bankers said, were double than that of outright transactions.

Moreover, life insurers were picking up securities through switches. These were not captured in the trade volume data.

The spread between one year and 23 years was 175 basis points last week against 160 basis points the previous week, implying that the yield curve was becoming steep.

Bankers said that the steep yield curve was on account of the low interest by banks for long dated securities. The low interest was also on account of the credit demand.

In fact, banks are seeing credit offtake at record highs of close to 30 per cent on a year-on-year basis. Incremental credit-deposit ratios are well over 100 per cent.

What was also of interest to the banks was that lending risks have considerably reduced. This in turn implied that few banks would like to remain in investments where the spreads were barely about two per cent.

So, bankers preferred to remain liquid by reducing the high investment-deposit ratio.

Any large-scale selling was ruled out since this would mean large depreciation losses. So, the option was to bring down the investment-deposit ratio gradually.

Another way of remaining liquid was to shrink the maturity of the investment portfolio.

In fact, this was one of the major factors leading to a steep yield curve, they added.

A steep yield curve also indicated that the economy was on a growth trajectory, implying that yields at the short ends would remain at the current levels.

Govt borrowing: What also indicated that the yields might remain at the current level was the possibility of government's under borrowing this year.

In fact, current indications are that the borrowings requirements are likely to be substantially lower than projections in view of good tax collections.

Besides, the real yield at the current inflation level of 4.07 per cent was 1.5 per cent.

Traders said that as long as the inflation remained at current levels, there was little scope for any big spikes.

But, another reason was foreign currency driven reserve money expansion.

Foreign currency inflows were to the extent of $3.062 billion, the highest a week. This has pushed up exchange reserves to $140.6 billion.

Large components of these inflows were float money from overseas corporate bodies and non-resident investors for investment in the initial public offerings.

These funds are likely to remain for a longer period evident from the forward premia movement.

Six months forward premia was at 0.9 per cent. The inflows were likely to create major sterlisation problems for the RBI, bankers said.

Consequently, they expect more prepayments of external debts in a bid to stabilise the markets.

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